It is a myth that bankruptcy mandates the loss of all your property. You can use exemptions to protect your property. If you “exempt” an asset, it will be protected from being sold to repay creditors. Protecting assets in bankruptcy usually depends on the exemptions available to you in the state where you live. Exemptions vary from state to state. In many states, you can choose between a state exemption system and the federal exemption system.
Many exemptions protect a specific type of property. For example, your house, car, or personal property may be protected by exemptions. In some instances, you can keep only a certain dollar amount of an asset protected, while in other instances, you can protect the total value of the asset. In some cases, you will need to use a “wildcard exemption” to protect a particular piece of property because no other exemption specifically addresses it.
If you have a choice of which exemption system to follow, you must elect all the exemptions in that particular system. You cannot mix and match exemptions of two different systems. Exemptions are used differently in Chapter 7 and Chapter 13 bankruptcy cases.
How Do Exemptions Work in Chapter 7 Bankruptcy?
When you file Chapter 7 bankruptcy, also known as liquidation bankruptcy, your bankruptcy trustee’s job will be to get creditors repaid to the fullest extent possible. Your assets and property become part of a bankruptcy estate, with a few exceptions. The trustee has the authority to sell the nonexempt property and distribute the funds to creditors according to their priority level. Exemptions in Chapter 7 determine how much property and which property you can keep.
The trustee will look at your equity in the property in determining whether to sell it. For example, if you owe a lender $5,000 on your motorcycle and the motorcycle is worth $15,000, the trustee will have to pay the lender $5,000 of the $15,000, and the motorcycle will only be worth $10,000 to the trustee. If there is a vehicle exemption of $10,000, the trustee will not sell it to pay creditors. However, if the vehicle exemption is $3,000, the trustee may sell the motorcycle, repay the lender $5,000, pay you $3,000, and use the remaining $7,000 to distribute among creditors, depending on the creditors that need to be paid back.
Most state systems and the federal system allow you to keep some equity in your house, your vehicle, and your personal property. In certain states, there is an unlimited homestead exemption, which allows you to keep your home in its entirety. Usually, goods and clothing are exempt unless they are worth a significant amount of money.
In some cases, even though you are unable to exempt an asset fully, the trustee may abandon it because the value is not significantly more than the exemption amount. Generally, it is expensive to conduct a sale for an asset, and it is only worth selling the asset if there will be something left over to pay back creditors. You will be allowed to keep property if the trustee abandons it.
How Do Exemptions Work in Chapter 13 Bankruptcy?
In a Chapter 13 bankruptcy, you can keep your property, but you must reorganize your debts and repay them according to a plan over a 3-5 year period. The amount you must pay certain creditors depends on exemptions, but certain debts must be paid in full, such as priority debts and secured debts.
Non-priority unsecured debts need not be paid back in full. The value of your nonexempt assets determines how much must be paid to non-priority unsecured creditors. This means that your plan payments will be lower each month, but you will have to use nonexempt property to repay creditors.
However, the trustee will not sell your nonexempt assets to repay creditors. Instead, you must pay the portion you cannot exempt to the creditors in order to get your plan confirmed and obtain a discharge. The purpose of this rule is to not leave your creditors worse off for you filing under Chapter 13 rather than Chapter 7.
For example, if your income permits you to pay $1,000 per month for five years, and your priority debts take about half this sum, you will still have $500 to pay back unsecured creditors with your income. Assuming the value of your nonexempt assets is $20,000, you will have to pay this sum to unsecured creditors. You can pay off this sum using the $500 of your income within 40 months.
Suppose, in the alternative, you only make $600 per month and priority debts eat through $500 of that per month. You will only have $100 a month to pay your unsecured creditors. If the value of your nonexempt assets is $20,000 and you have five years (60 months) to pay that $20,000 to unsecured creditors, your income is insufficient. You would need about $333.34 per month in addition to the amount you pay to priority creditors order to get your plan confirmed. Since you only have $100 per month for unsecured creditors, you would not have sufficient income to get a Chapter 13 bankruptcy plan confirmed.